This study reviews Albania's historical and political background, as well as economic developments in 1991. It describes the centrally planned economic system up to the onset of reform and analyzes economic performance in the 1980s.

An Overview

Until the beginning of 1991, and for more than four decades, Albania was one of the least known and less accessible countries in the world. It secluded itself in self-imposed isolation and was ruled by an authoritarian regime that professed to adhere strictly to Marxist ideology and Stalinist practices in an attempt to carry out one of the most far-reaching experiments in socialist orthodoxy. Although not much was known about the country’s economy, Albania was usually characterized as the poorest and least developed nation in Europe, probably the only one in the continent with standards of living resembling Third World countries.

Although initially regarded as a bastion of resistance against the radical changes taking place in the socialist world, Albania had, by the middle of 1991, joined the reform movement sweeping through Eastern Europe. In June 1991, the first noncommunist multiparty coalition government in the postwar era was formed. Diplomatic relations with many countries were renewed, and Albania joined the International Monetary Fund (October 15, 1991), the World Bank, and the European Bank for Reconstruction and Development, among other international organizations.

As Albania attempts to reform its system and rejoin the world economic community, and as more information about the country becomes available, the picture that emerges is one of an economy in the midst of a very serious and profound crisis that is probably deeper than that experienced by other reforming socialist countries. It is undergoing a drastic contraction in economic activity (30-40 percent during 1990-91), a sharp deterioration in its external accounts, a virtual exhaustion of foreign exchange reserves, and a rapid buildup of external debt and arrears.

In this context, the newly available information on the evolution of key economic and financial variables in recent years, as well as on the intricacies of the policies followed, assists in the search for the roots of the current crisis. Although it could be claimed that such fundamental reforms as the abandonment of central planning and the embracing of a market-oriented system would relegate the study of even the most recent economic developments in reforming countries to the realm of economic history, it is clear that the understanding of events and of the framework within which they have taken place could contribute considerably to the design of appropriate solutions. This paper seeks to present a complete and concise picture of the traditional Albanian economic system, much of which still exists, an analysis of the main economic developments and policies during the 1980s, and an account of the most recent evolution of the economy, as well as of the unfolding of the economic reform process.

The present economic crisis in Albania is not just the consequence of recent events. It reflects the buildup of structural problems, policy mismanagement, and financial imbalances deeply rooted in the development strategy followed since World War II. Like other socialist economies, Albania’s economic model was based on two principles: complete reliance on central planning and rejection of private ownership of means of production. Although enforcement of these principles was carried to an extreme unknown in many other socialist countries, and almost all forms of private property were eliminated, the “Albanian model” was unique in that it included a third principle: the idealization of national self-reliance as a guiding tenet of economic policy, which, in practical terms, gave a central role to the pursuit of economic autarky. This strategy was symbolized by the constitutional ban on external credit, aid, and investment that was adopted in 1976 and culminated in the self-imposed financial isolation of Albania in the 1980s.

Until about the end of the 1970s, the Albanian economy followed the path of some other small developing countries—socialist and nonsocialist alike—in disregarding economic incentives, the central role of market forces, the principle of comparative advantage, and the importance of financial discipline. As a result, economic performance was impaired by relative price distortions, by the financial burden of consumer and enterprise subsidies associated with a system of rigidly fixed prices, and by a pattern of production specialization that led to mounting mismatches between supply and demand. For a time, however, the consequences of these policies were concealed by Albania’s access to substantial external resources, from the then U.S.S.R. in the 1950s and from China in the 1960s and 1970s. This transfer of external savings not only allowed the system to neglect the cumulative effects of policy mistakes but also fueled slow but steady growth and even enabled the accumulation of significant foreign exchange reserves.

Box 1.A Profile of Albania

Albania is located in the Balkan peninsula in south-eastern Europe, on the eastern shore of the Strait of Otranto across from Italy. It is bordered by Yugoslavia to the north and east, by Greece to the south, and by the Adriatic and Ionian Seas to the west.

The smallest of the Balkan countries, it has an area of 11,100 square miles (28,748 square kilometers), a population of 3.26 million, and GDP per capita estimated at slightly more than $600 in 1990. Albania is predominantly mountainous—roughly three fourths of its territory consists of mountains and hills in the northern, central, and southern parts at elevations over 200 meters above sea level. In contrast to the rugged terrain and limited arable land in the mountainous regions, the western plains beside the Adriatic Sea are endowed with very fertile soil.

Reflecting a varied geological structure, Albania has a wealth of natural resources, including chromium, copper, iron/nickel, coal/lignite, oil, bauxite, phosphorate, asbestos, bituminous sands, pyrites and nickel silicate, as well as limestone, sands, marble, and clays. The major resources currently exploited are chromium (third largest producer in the world), copper, iron/ nickel, limestone, phosphorate, and coal.

Compared with other European countries, the agricultural sector (including forestry) is relatively important; during the 1980s, it accounted for 33 percent of the country’s net material product (NMP), and employed nearly 50 percent of the total working population. The share of the industrial sector in NMP was 44 percent, while that in employment was 22 percent. The remainder was accounted for by the services sector, of which construction activity was the most significant. Transportation and communications systems are poorly developed and are similar to those in low-income developing countries.

Sources: Data provided by the Albanian authorities; and World Bank, Social Indicators of Development, 1989.

1Refers to most recent year (usually 1989) for which data are available.

2At commercial exchange rate of leks 8 = $1.

3Includes forestry.

4Permitted only since the second half of 1990.

Sources: Data provided by the Albanian authorities; and World Bank, Social Indicators of Development, 1989.

1Refers to most recent year (usually 1989) for which data are available.

2At commercial exchange rate of leks 8 = $1.

3Includes forestry.

4Permitted only since the second half of 1990.

Albania’s distinctive experience began, however, in 1978 when it interrupted economic and financial relations with China and felt the full enforcement of the 1976 constitutional ban on all forms of foreign finance. Although many countries have been able to cope with the cessation of foreign financing, it usually requires macroeconomic adjustments. Albania did not adjust to the new situation, and aggregate demand, fueled by monetary growth and fiscal imbalances, continued to grow rapidly. Moreover, to manage the economy in conditions of financial autarky, it was necessary to tighten state command of the system further, thereby aggravating the misallocation of resources. This also accelerated the decline in productivity caused by the Government’s commitment to provide employment for a rapidly increasing labor force and by the continuous deterioration and technological obsolescence of the capital stock, which had been outdated already at installation. Under such circumstances economic growth decelerated substantially, from nearly 5 percent in the 1970s to an annual average of about 1 percent during the 1980s.

Nevertheless, the crisis was able to be postponed for almost a decade because of the past accumulation of foreign exchange reserves, the ability to maintain a broadly balanced current account in nonconvertible currencies, favorable developments in Albania’s terms of trade, and new exports of primary commodities. But over time the accumulated repercussions from the intensified macroeconomic imbalances, along with growing fiscal deficits and rapid monetary expansion (especially in the second half of the 1980s) and increasing shortages of consumer goods, became fully apparent. Moreover, most recently, the consequences of protracted microeconomic distortions and macroeconomic mismanagement were exposed further through the increased import requirements arising from domestic supply bottlenecks, the collapse of export markets in Eastern Europe, the adverse turnaround in the terms of trade, and the depletion of foreign reserves.

In 1990, the fiscal situation deteriorated markedly, with the deficit reaching a level of over 16 percent of GDP. Monetary expansion exceeded 20 percent, reforms were undertaken only timidly, and, in a striking reversal of the previous policy of abstinence from foreign financial sources, substantial payments arrears with foreign commercial banks rapidly accumulated, severely damaging Albania’s reputation in international financial markets. Although exceptionally adverse weather in 1990 contributed to the sharp decline in output, the continued collapse in production carried over into 1991, with a severe aggravation of financial imbalances. Under such conditions, the road to recovery requires not only decisive macroeconomic adjustment but also a complete overhaul of the economic system through the adoption of a comprehensive program of institutional and structural transformation. The initial steps toward that goal through the end of 1991 are described in Section V of this paper.

Historical and Political Background

Albanians are believed to be descendants of the Illyrians, an Indo-European tribe, who began inhabiting the Balkan peninsula about four thousand years ago. The term, Albania, is derived from the name of an Illyrian tribe, Albanoi, who are believed to have inhabited the central part of present-day Albania. The Romans conquered the Illyrian territories and ruled for more than five centuries. After the decline of the Roman Empire, the Illyrian territories continued to be subjected to foreign invasion—the Goths and the Huns in the fourth century, the Bulgars in the fifth century, the Slavs in the sixth and seventh centuries, the Normans in the eleventh and twelfth centuries, and the Serbs in the fourteenth century.

At the end of the fourteenth century the Ottomans invaded Albania. Skanderbeg, the most revered Albanian hero, successfully fended them off for twenty-five years. After his death in 1468, Albania became a part of the Ottoman Empire, and a predominantly Christian population was brought under the influence of Islam during this period. (In 1967 Albania became the first self-proclaimed atheist country and strictly outlawed all religious practices. At that time, Albanians were roughly 70 percent Muslim and the rest Christian, mostly of Eastern Orthodox denomination.) Albanian nationalist movements began to gain prominence during the second half of the nineteenth century, but it was not until 1912 that Ismail Quemal proclaimed the country’s independence. After a period of political turmoil during World War I (1914-18) and for some time thereafter, King Zog ruled during 1928-39, exercising absolute power.

During World War II (1939-45), the country was annexed by Italy (1939) and later occupied by Germany (1943). The Allied forces never occupied Albania; it was freed from German occupation by local partisans affiliated with the Albanian Communist Party (founded in 1941), militarily supported by the Anglo-American command in Italy, and politically backed by the Yugoslav Communist Party. In effect, the Albanian communists, with a strong political organization and substantial armed partisan groups, filled a political vacuum that existed after the war.

After November 1944 Albania experienced an uninterrupted period of strong centralist rule under Enver Hoxha, the unchallenged communist leader until his death in 1985. Centralism, in the Albanian context, meant both centralized planning and direction of the economy and central control of the political, social, and cultural life of the country and its people.

Albania’s turbulent and long historical experience with repeated foreign invasion had instilled a strong sense of patriotic fervor and nationalism in its people and set the background for the fiercely independent foreign policy of the new government, reflected in dramatic shifts in Albania’s foreign alliances. After World War II, the political position of the Albanian Government was initially influenced by the Yugoslavs (1945-48), followed by the Soviets (1949-61) and the Chinese (1961-78). Albania joined the Council for Mutual Economic Assistance (CMEA) in 1949 but withdrew in 1961.

The break with Yugoslavia in 1948 was an outcome of the Albanians’ concern that Yugoslavia had plans to incorporate Albania as its seventh republic. The alliance with the former Soviet Union was financially rewarding, but Albania was deeply committed to the Stalinist model of heavy-industry-led development and felt compelled to shun Soviet pressure to develop its raw material base. Following ideological and political tensions, the diplomatic and financial ties with the former U.S.S.R. were broken in 1961, and China became Albania’s closest ally. However, after Mao’s death in 1976, the Chinese-Albanian relationship suffered a political setback and by 1978 the break with China was complete. In 1976 a new Constitution was adopted (see Box 2 for details), which abolished all remaining private property and banned foreign aid, credit, and investment.

After Hoxha’s death in 1985, Ramiz Alia became leader of the Communist Party and President of Albania. Since 1986, Albania has begun to show an interest in emerging from its isolation and in improving relations with the West. The dramatic collapse of the communist regimes in Bulgaria, Czechoslovakia, the former German Democratic Republic, Hungary, Poland, and Romania set the stage for the fall of the last bastion of Stalinist rule in Eastern Europe. However, it was not until the second half of 1990 that a democratization process began with the formation of opposition parties, and the first pluralistic elections were held in March 1991. The Albanian Labor Party emerged with an absolute majority, but the Government collapsed under pressure of increasing unrest and dissatisfaction among the population. In June 1991, a coalition government was formed. New elections were held in March 1992, with the Democratic Party winning a clear majority.